Assume that you believe that the yield curve is going to steepen in the near future. You are going to devise a trading strategy using the 5-year Treasury coupon bond with par value of $100 and the 10-year Treasury coupon bond with par value of $100 that will take advantage of this relative value trade.

You do not want to take on any other risks, besides the risk that you might be wrong about the yield curve steepening.

Assume that the 5 year bond has a coupon of 4% and a yield to maturity of 3%.

Assume that the 10 year bond has a coupon of 4.5% and a yield to maturity of 3.5%.

2. Assume that you will use 10,000 units of the 5-year bond. How many units of the 10- year bond will you need to use in your trade? Round DV01 and bond price calculations to 4 digits.

3. State the balance sheet when you set up your trade. Assume that you use cash to fund the long position and that the cash you receive from the short position is listed separately on your balance sheet. Round bond price calculations to 4 digits.

4. Assume that after three days the 5 year YTM is now 3.30% and the 10 year YTM is 3.9%

Without doing any math, are you happy or sad?

5. Restate the balance sheet by recalculating the bond prices at the new YTMs. Ignore the fact that the bond maturities have changed slightly. (in other words, use 5 years and 10 years respectively for the bond maturities, despite the reality that both bonds have slightly shorter maturities because three days have passed). Also ignore any interest you might have earned on your cash position and any costs of short selling. Round bond price calculations to 4 digits.

6. What is your return on equity? State as a percent.

7. What is the BEY (annual rate) of this 3-day return on equity? (Assume 365 days in a year). State as a percent.

8. What is the Effective Annual Yield of this 3-day return on equity (assume 365 days a year). State as a percent.